Thinking | 24 December 2019

ASIC’s draft guidance on design and distribution obligations released

In this article, we outline briefly draft regulatory guidance released by ASIC relating to design and distribution obligations (DDO) that will come into effect for financial product issuers and distributors on 5 April 2021, and offer some reflections on some interesting positions taken by ASIC.

Key points

  • ASIC’s consultation package sets out ASIC’s proposed regulatory guidance on the implementation of the DDO regime.
  • ASIC’s guidance is principled-based, therefore allowing issuers and distributors a fair degree of flexibility in complying with the DDO regime.
  • The draft guidance gives ASIC’s views on some key issues that the industry has been deliberating to date.
  • Consultation closes on 11 March 2020, and the regulatory guide is expected to be released next year.

Background

The DDO regime was enacted under the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 (DDO & PIP Act), which received royal assent on 5 April 2019.  We examined the effect of this Act earlier this year.  Draft exposure regulations in relation to the DDO regime were also released, which we considered in our article, and a final form of these regulations were enacted on 16 December 2019.  The regime commences on 5 April 2021.

On 19 December 2019, ASIC released for public consultation:

The Draft Guidance sets out, among other things:

  • ASIC’s expectation that issuers and distributors will create and implement a documented and consumer-centric product governance framework;
  • ASIC guidance on the interaction between the DDO regime and existing law on personal advice and responsible lending; and
  • ASIC’s approach to administration of the regime.

Summary of key proposal and regulatory positions

Set out below is a summary of ASIC’s proposals in CP 325 and key positions on regulatory issues taken both in CP 325 and the Draft Guidance.

RequirementDescription
Product governance framework requirement Issuers and distributors should design, document, implement, monitor, and report on a product governance framework. This refers to the systems, processes, procedures and arrangements in place to ensure that they comply with the DDO. At the product design stage, an issuer should consider the ‘choice architecture’ of its financial product to ensure that it is consistent with the target market, including, for instance, the impact of complexity and frictions in choices, processes and information.
Not take advantage of behavioural biases Issuers and distributors should not take advantage of behavioural biases or other factors that can impede consumers from obtaining appropriate products. For example, ASIC says the effect of behavioural bias on consumer interaction with information should be considered.
Issuer must make target market determinations (TMD) for each product The issuer is required to make the TMD publicly available. ASIC does not consider the TMD to be a ‘consumer-facing disclosure document’.
 ASIC does not propose to give definitive guidance on the content and form of a target market determination and, in particular, the formulation of a target market.
 For new products, issuers should identify the target market and design financial products that are likely to be consistent with the likely objectives, financial situation and needs of consumers in that target market. For existing products, issuers should still critically assess the product (and its features) and identify the target market under the design and distribution obligations by reference to the likely objectives, financial situation and needs of consumers for whom the product would likely be consistent.
 ASIC does not propose to give any definitive formulation of how a target market should be described in a target market determination. However, ASIC considers specific examples (credit cards, reverse mortgages, superannuation, consumer credit insurance, low-value products, and basic banking products) and gives key considerations when identifying a target market for such products.
 Issuers should not identify target markets predominantly based on how much the consumer understands the product, as the DDO regime requires issuers to consider objectively the suitability of a product for a consumer class.
 In preparing a TMD, issuers should consider the ‘negative target market’.
 For certain products where the application of the TMD obligation is not ‘straightforward’, ASIC gives guidance on how TMDs should be approached in relation to superannuation products, platforms or IDPSs, packaged or bundled products, and products that are customisable by consumers at the point of sale.
Issuers must review TMDs to ensure they remain appropriate While ASIC does not propose to set out standard review timelines or what events should trigger a review, it does provide some examples of what types of information could be considered when identifying review triggers. For example, issuers of interests in managed funds could consider data such as product performance, consumer complaints, and product fees.
 ASIC does not propose to prescribe in guidance what types of information issuers should require from distributors to enable issuers to determine when a TMD may no longer be appropriate, nor the reporting period for complaints.
 Issuers should take into account all available information on a product when reviewing a TMD. This includes information held by the issuer about consumers, information collected from distributors, information collected from consumers, and information from other sources including AFCA decisions.
Issuers must take ‘reasonable steps’ that will, or are reasonably likely to, result in the distribution of financial products consistent with the TMD When an issuer contemplates that the target market includes consumers who will acquire the product as part of a diversified portfolio, the reasonable steps obligation requires the issuer to manage the risk of the product being sold to consumers who do not have a diversified portfolio.
 In relation to what constitutes ‘reasonable steps’ for an issuer, ASIC has a principles-based approach, as ASIC states that issuers are ‘best placed’ to determine these steps. ASIC identifies a number of factors that may be relevant to this obligation, including:
• the distribution conditions;
• the marketing and promotional materials;
• the selection of distributors;
• the issuer’s supervision and monitoring of distributors;
• the management of conflicts; and
• whether issuers have provided distributors with sufficient information to help them ensure that distribution is consistent with the target market determination.
Issuers must notify ASIC of any ‘significant dealings’ that are inconsistent with the TMD for a financial product ASIC states that certain factors are relevant to whether a dealing is ‘significant’, including the proportion of consumers outside the target market acquiring the product, the actual or potential harm to such consumers acquiring the product, and the nature and extent of the inconsistency between the target market and the product’s distribution. ASIC also expects requires issuers to notify ASIC of what steps (if any) have been taken in relation to persons affected by the dealings, and what steps will be taken to ensure that it does not happen again.
Issuers must keep records Issuers are required to keep records of decisions made in relation to TMDs for up to seven years. ASIC has no specific proposals about this requirement.
Distributors must take reasonable steps that will, or are reasonably likely to, result in the distribution of financial products consistent with the TMD ASIC explains that issuers that directly distribute their products will need to comply with the reasonable steps obligation for both issuers and distributors.
 ASIC states that distributors are best placed to consider the appropriate approach, and what constitutes reasonable steps will depend on the ‘scale, sector and distribution method employed in the distributor’s business model’. ASIC considers that ‘reasonable steps’ for a distributor will also depend on an issuer’s degree of control over the distribution process. A distributor, however, cannot satisfy the obligation by doing no more than comply with an issuer’s distribution conditions.
 To illustrate the reasonable steps obligation, ASIC proposes an example for insurers acting in their role as distributor when renewing general insurance policies.
 ASIC proposes that, during the sales process, the systems and processes used by distributors should enable them to acquire sufficient information about a consumer to satisfy the reasonable steps obligation, but should not leave the consumer with the impression that their personal circumstances have been considered by the distributor. ASIC provides specific recommendations including using ‘knockout’ questions, and not using individuals authorised to give personal advice.
 ASIC proposes that, when a distributor becomes aware that a consumer outside the target market is trying to acquire the product, they are not prevented from selling the product to the consumer so long as reasonable steps have been taken. If this happens frequently, however, this may bring into question whether the reasonable steps obligation is being satisfied.
 ASIC proposes that a TMD for a financial product should be considered by a financial adviser in providing the advice and meeting their best interests duty.
 ASIC proposes that information gathered as part of responsible lending obligations may help distributors form a reasonable view on whether the consumer is reasonably likely to be in the target market.
Seeking information for other reasons may be personal advice Section 766B(3A) of the DDO & PIP Act provides that asking information solely to determine whether a person is in a target market does not constitute personal advice. However, the Draft Guidance explains that a distributor will not be able to rely on this if they set up the interaction in a way that gives the impression that the consumer’s personal circumstances are being considered.
Distributors cannot distribute a product unless a TMD has been made The Draft Guidance explains that a distributor may distribute a product if it reasonably believes (after making all reasonable enquiries) that a TMD has been made, or a TMD is not required. ASIC does not have proposed specific guidance on this obligation.
Distributors must keep records Distributors are required under the DDO & PIP Act to keep records of distribution information in relation to products for up to seven years. ASIC has no specific proposals about this requirement.
Distributors must report information to the issuer ASIC does not propose to give specific guidance on information exchange arrangements between issuers and distributors because this is a ‘commercial’ matter. However, following consultation feedback, ASIC states that they may consider providing some guidance if this will ‘promote consumer or competition outcomes’.
 Distributors are required under the DDO & PIP Act to report to issuers:
• whether it received complaints about the product during a reporting period and if so, the number of complaints received;
• information of the kind specified by the issuer in the TMD that was acquired by the distributor during a reporting period; and
• significant dealings in the financial product that are inconsistent with the TMD.
ASIC’s administration of the DDO regime The Draft Guidance explains how ASIC will exercise its powers to make a stop order in relation to breaches of DDOs. It also explains that ASIC’s product intervention powers complement the DDO regime.
 ASIC proposes to identify factors that ASIC will take into account when considering whether to exercise their relief powers in relation to the DDO regime.
 ASIC proposes that, where ASIC grants relief from disclosure obligations to a financial product, it will not automatically follow that relief from DDOs is also granted. The disclosure regime and DDO regime have different policy rationales, so ASIC will need to make separate relief decisions.

General observations

In our view, the principles-based approach to the DDO regime should be welcomed by industry.  ASIC recognises that there are many financial products in the market, along with many ways to develop, promote and distribute financial products.  We consider it be an appropriate regulatory response for ASIC to give industry participants the flexibility they need to respond to a far-reaching and new regulatory regime.  Having said that, there are some expectations of ASIC that go above and beyond the black-letter law, such as expecting issuers to ‘manage the risk’ of a financial product being widely sold to investors who do not have a diversified portfolio (where the TMD states the product is suited for investors who have or want a diversified portfolio), without explaining how this risk-management does not move into the giving of personal advice by the issuer.

In the consultation materials, ASIC has already given important sign-posts to the industry.  For example, the fact that ASIC considers that a TMD need not be consumer-facing gives issuers and distributors the opportunity to prepare a TMD that is more meaningful for their day-to-day product manufacturing and distribution processes.  Further, the reading down of the personal advice exemption in section 766B(3A) is deliberate.

While ASIC states that arrangements between issuers and distributors are ‘commercial matters that issuers and distributors can determine among themselves’, the indirect effect of the DDO regime on issuer/distributor arrangements will be significant.  For example, the Draft Guidance explains that an issuer’s processes to assess a distributor’s capacity to comply with the TMD distribution conditions, and the degree of an issuer’s supervision and monitoring of distributors, will be relevant to ASIC’s consideration of whether the issuer has satisfied their reasonable steps obligation.  This is likely to increase the amount of due diligence an issuer will need to undertake, and the level of involvement they need to have, in their distribution network.  It will also increase the costs of product manufacture and distribution, and one commercial question in relation to the DDO regime is whether such costs will be passed on to consumers.

In recognition that the DDO regime is a new approach to financial product regulation in Australia, ASIC states in CP 325 that they ‘expect to have a constructive relationship with industry during the implementation phase’.  This is undoubtedly useful given the far-reaching nature of the DDO regime.

Contact

Harry New

Harry has represented a number of listed public companies, large private companies and government organisations. His clients include all...

Vince Battaglia

Vince Battaglia is an experienced funds management and financial services practitioner.  He has worked in global and national law...

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